Oil profits are dizzy with spin

David Lazarus

Published 4:00 am, Wednesday, May 10, 2006

Last week's column on obscenely fat profits pocketed by the likes of Exxon Mobil and Chevron drew plenty of apoplectic responses from defenders of the industry, mostly pointing out that the companies' profit margins are only in the 9 percent range, less than that of many other big corporations.

This is the same argument industry execs make when called to account by lawmakers, regulators and the like.

"The latest data show that in 2005, oil and gas earned 8.5 cents on every dollar of sales compared to an average of 7.7 cents on the dollar for all U.S. industry," the American Petroleum Institute, a leading trade group, said in a statement last week.

"The numbers do not lie and they do not have to be spun," the institute said. "They clearly indicate that companies that provide the fuel to keep America moving are on a par with other industries when it comes to what they earn for their shareholders."

The numbers may not lie, but they are in fact dripping with spin.

While the oil industry habitually downplays its profitability when speaking to lawmakers, the media or the public, it sings an entirely different tune when addressing investors and others in the financial community.

In such cases, industry officials emphasize not their relatively benign profits as a percentage of total revenue but their very impressive "return on capital employed," or ROCE -- their earnings as a factor of money spent to make money.

"In our view, ROCE continues to be the best overall measure of financial performance given the long-term and capital-intensive nature of our industry," he said. "I would be cautious of anyone who tries to de-emphasize it."

Exxon reported first-quarter net income of $8.4 billion on sales of $89 billion. San Ramon's Chevron reported quarterly net income of $4 billion on sales of $54 billion.

What is Exxon's return on capital employed? Tillerson boasted to analysts that the company led the industry last year with a return of 31 percent. In other words, Exxon pocketed 31 cents for every dollar spent on expanding its business.

Chevron posted a return on capital employed of 22 percent last year. Collectively, the five largest oil companies -- Exxon, Chevron, ConocoPhillips, Shell and BP -- saw an average return on capital employed of nearly 27 percent.

This is more than double the average return on capital employed for all U.S. industrial companies, according to figures compiled by Innovation & Information Consultants, a Massachusetts financial consulting firm.

"Return on capital employed is the correct measure for big manufacturing or industrial types of industries," said Peter Ashton, president of Innovation & Information Consultants. "It tells you what your hard assets are generating in terms of profit."

So what does an average 27 percent return on capital employed tell us?

"It says these guys are making huge profits," Ashton replied. "You can't argue that these profits aren't extraordinary, because they really are."

Tyson Slocum, who heads the energy program at Public Citizen, a Washington advocacy group, said the oil industry is attempting to mislead when it stresses relatively mediocre profits as a percentage of sales to everyone but its financial peers.

"They say one thing to the public but they have a whole other line for shareholders and investors," Slocum said. "The industry can't have it both ways. If they think that return on capital employed is the best way to measure their performance, then that's the measurement we should use.

"It's completely disingenuous for them to tell Wall Street how great they're doing and then use a different measurement to tell the general public, 'Woe is us.' "

I asked representatives of Exxon and Chevron for information about their profit margins. Both e-mailed figures, sourced to the American Petroleum Institute, showing that oil companies earn less as a percentage of total sales than banks, drug companies and softwaremakers.

In its statement last week, the institute explained that the oil industry uses profits as a percentage of sales when dealing with the public "because that is a figure that is the most widely understood and relevant to consumers."

It acknowledged that return on capital employed is "another measure of industry performance," but insisted that "even the earnings from investment figures show clearly that the oil and natural gas industry is in line with other industries."

To support this contention, the institute cited figures from 2004, when oil averaged about $40 per barrel. It was trading Tuesday above $70.

The institute insists the 2004 numbers are the most recent data available from the U.S. Energy Department. "We're not trying to hide anything," said Rayola Dougher, the institute's manager of energy markets. "This was the latest data we had."

She might want to check out the Web site of the Energy Department's Energy Information Administration. It says oil averaged more than $56 last year and will likely average about $65 this year.

What will that mean for the oil industry's return on capital employed?

"I'm sure it's up," Dougher said. "But I don't know by how much."

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Besides, that's not something ordinary consumers need to concern themselves with. All they need to know is that the oil industry is barely scraping by.

Or so the industry likes to say.

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